CNN: Currency Confrontation

This week, the U.S. Senate considered a bill that threatens to impose broad-ranging sanctions on China unless it revalues its currency. The Senate vote on the bill - which looks like it may have enough support to pass - had been planned for Thursday evening, but ran into partisan maneuvering, and is now expected to take place early next week. If it does pass, attention would then shift to the House of Representatives, where there is mounting pressure to vote on the measure, and then on to President Obama, who would face the uncomfortable decision whether to veto the bill or sign it into law.

For those interested in exactly what the bill does, you can find a good summary here. The bill the Senate is currently considering is the latest incarnation in a series of proposals put forward by Senator Chuck Schumer (D-NY) over the past several years, which have waxed and waned in support in line with the level of frustration felt in Washington with China's on-again off-again moves to permit a stronger yuan. (This time around, the situation is a little different. China has actually been allowing the RMB to gradually appreciate, by 5.2% over the past 12 months, which along with mounting Chinese domestic inflation means that Chinese goods are at least 10% more expensive than they were a year ago. The motivation in Congress this year has less to do with Chinese inaction than with growing election-year frustration over persistently high U.S. unemployment.)

Although the current bill does not actually single out China, or impose any sanctions directly, its provisions would place significant pressure on the President to start sanctioning China in various ways or explain why he isn't. It also would set the stage for similar action against any other country with a fixed or semi-fixed exchange rate whose currency policy the U.S. doesn't like.

Yesterday, CNN's Jaime FlorCruz interviewed me about the Senate debate, and the broader issue of what's causing the trade imbalance and what China and America should be doing about it. I've posted it here, and you can also access the original version here. (You can also check out what I had to say in Thursday's Washington Post.)

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1)How serious is the U.S. trade deficit with China?

U.S. trade deficit with China has steadily grown over the past decade. In 2010, it reached $273 billion, over 40% of America's global trade deficit, but still amounted to less than 2% of GDP. In fact, America's global trade deficit peaked in 2006 and has declined substantially, largely due to expanding exports.

The real problem isn't so much the absolute size of the U.S.-China trade imbalance, but the struggle to find sources of growth in a stagnant global economy.

2) The U.S. will hold a presidential election next year. How is the trade dispute with China playing out in America?

The number one election issue is going to be jobs, so every politician wants to show that they're doing something about jobs. China's trade imbalance with the U.S. is a real issue: If China's markets were more open, if it was encouraging consumer demand instead of piling up reserves, it could help boost job growth in the U.S. So there's a temptation to seize on China's currency policy as a "silver bullet" that will solve this concern, by making U.S. goods cheaper and Chinese ones more expensive, even though the real problem is more complex than that.

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3) What impact will the Senate bill have if passed?

The immediate concern would be retaliation, provoking a trade war with China. Even if China didn't opt for actual retaliation, it could challenge the U.S. sanctions with the World Trade Organization, and China might very well win. One of the reasons the U.S. has always hesitated in slapping sanctions on China over currency is the fear that we might be shooting blanks.

4) Why so?

It's far from clear that twisting China's arm to strengthen its currency will have the effect we might hope. We've actually seen this movie before. In the Plaza Accord in 1985, Japan agreed, under considerable U.S. pressure, to strengthen its currency in order to combat the growing U.S. trade deficit. The yen doubled in value, but to everyone's surprise, it had virtually no impact on the trade balance, because there were subsidies, trade barriers, and other policies in place in Japan that countered the stronger yen and prevented an adjustment from taking place. Back China into a corner and force it to accept a stronger yuan, without embracing the kind of economic adjustment that really requires, and I'm afraid we'll see a replay of the Plaza Accord.

5) What is the fundamental reason causing the trade deficit?

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The cheap yuan is one factor, but it's only one piece of the puzzle. Other factors include obstacles to market access, China's failure to protect intellectual property rights, export tax rebates, subsidized inputs, subsidized credit, and soft budget constraints for Chinese state-owned companies.

There are a whole host of factors in the Chinese economy besides currency that distort price signals in favor of exports and discourage imports. To their credit, American negotiators have been placing more and more emphasis on these issues lately, rather than focusing exclusively on currency as some kind of "silver bullet."

6) Why should China revalue the renminbi?

When China intervenes to keep the yuan from rising, in order to protect export growth, it ends up accumulating trillions of dollars in official reserves that it has to somehow invest, leaving it exposed to losses. It also injects trillions of yuan into its domestic economy, fueling inflation and asset bubbles. The fact is, when you run massive trade and investment imbalances, as China is doing, you're going to get an adjustment, one way or the other. It's either going to take place through external prices (exchange rates) or internal prices (inflation).

7) What will be the pros and cons for China?

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There will be losers. Some Chinese exporters, especially those with razor-thin margins and no reliable competitive advantage, may lose their markets and go out of business. But there will be winners too. A stronger yuan would give the average Chinese citizen greater buying power and an improved standard of living.

8) Some observers argue that, if the renminbi revalues and the Chinese exports to the U.S. become expensive, the American consumers will have to pay more for them - and thus will be hurt too. Your view?

That's absolutely true. Just as a stronger yuan will mean that Chinese consumers will enjoy greater buying power, American consumers will lose some of the buying power they've enjoyed over Chinese goods. Their dollars will buy less. But the focus in America right now is on jobs, not buying power. The problem this past decade is that Americans' buying power has led us to consume more than we produce, which means more than we could ultimately afford, and as we've all come to learn, that's just not sustainable.

9) Will further revaluation of the renminbi help stop the loss of jobs in the U.S.?

A stronger yuan is not going to bring back jobs in labor-intensive, low-tech industries where the U.S. has no real competitive advantage. Those jobs will go to Bangladesh or Vietnam before they come back to the U.S. But a Chinese consumer with greater buying power - if accompanied by greater openness and fairer treatment for American companies in the Chinese market - will translate into more opportunities and more jobs in sectors where the U.S. has a real advantage. Twisting China's tail won't get us there, however. A market-based exchange rate has to be part of a more comprehensive win-win solution.